Last year, Southeast Asia’s low vaccination rates and strict lockdowns reverberated across the world, mostly in the form of supply shortages. The region is a key manufacturing center for electronics and labor-intensive goods, and the disruptions—ranging from footwear and textiles from Vietnam and semiconductors from Malaysia—have been most acute in the United States. Given Southeast Asia’s crucial role in the global supply chain, its performance in 2022 is important for not just its 655 million people but for the entire world.

COVID-19 has hit the region hard: contact-based economies, especially tourism, account for a large share of GDP; governments have limited ability to provide financial support; and acquisition and distribution of vaccines has proved difficult. These limitations formed a perfect storm in the second half of 2021, when the Delta variant caused a spike of infections, and regional policymakers had to resort to lengthy lockdowns, which weakened the economy and disrupted tourism, manufacturing, and global supply chains. 

But the region’s growth is poised to make a gradual comeback this year. Many countries now have boosted their vaccination efforts, prompting policymakers to be more willing to refrain from ordering lockdowns and use gentler containment measures. On the fiscal side, government spending, according to budgets unveiled thus far, will be helpful to ensure the recovery takes place, except for Thailand. Malaysia’s and Thailand’s governments are willing add more debt to boost growth, even if they must raise their deficit ceilings (Vietnam is considering this move as well).

But Southeast Asia should not bask in such a recovery, as much of it is making up for underperformance in 2021, especially in domestic demand. The cyclical rebound is fragile, contingent on the resolve of policymakers to push ahead on five factors that will contribute to a much more challenging external environment.

First, tourism isn’t going to fully normalize in 2022, even if the region presses ahead with reopening. This is especially true with Chinese tourists—who accounted for about one-third of all visitors pre-pandemic—staying home. Even if the country can attract the rest of the world to return to its beaches and temples—which is unlikely, as travel in Asia remains restricted and appetite to travel has been dampened by the Omicron variant—it still needs to make up for a substantial drop-off. 

Second, while Southeast Asia is finally sorting out its supply chain disruption and normalizing production and exports, the global economy is slowing, especially in China. That deceleration in China, Europe, and the United States is likely to dampen the region’s export growth in 2022. 

Third, external financial conditions, led by the U.S. Federal Reserve, are tightening and spilling over to the region via Southeast Asia central banks’ interest rate hikes. The region can stomach gentle rate hikes, but a much fiercer cycle may significantly derail the recovery, especially with rising debt. 

Fourth, increasing domestic demand in 2022 will push Southeast Asia’s energy consumption higher, which will put pressure on its capability to balance between short-term energy supply needs and longer-term objectives of more sustainable growth through clean energy. 

Fifth and finally, domestic politics and geopolitics are a concern in 2022. The Philippines is having a presidential election in May, and the expansionary fiscal budget is a way for the outgoing president to grow the Philippines out of its funk. However, political considerations may outweigh long-term economic needs. Thailand’s politics have clouded its economic outlook, as the government focuses on short-term survival over longer-term solutions, such as how to limit its overdependency on tourism. Malaysia, where political gridlock has hampered its ability to tackle long-standing issues, could have a general election called, especially with its largest-ever budget in 2022.

The region leaves behind a year of disappointing growth, much of it due to its own domestic suppression, and looks forward to a more hopeful 2022. And it has reasons to be: Southeast Asia is less likely to have to resort to lockdowns this year, a key reason for its underperformance in 2021. Policy support is coming via fiscal policy, although less so for monetary. While such optimism is warranted, caution is wise, as the region will likely face a more challenging external environment, requiring policymakers and investors to be on alert to navigate choppier water.

Source: Natixis Research, Carnegie Endowment